To solve for Q*, we take the square root of both sides to find:

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

VII. Short-Term Financial Planning and Management

21. Credit and Inventory Management

© The McGraw-Hill Companies, 2002

PART SEVEN Short-Term Financial Planning and Management economic order quantity (EOQ)

The restocking quantity that minimizes the total inventory costs.

This reorder quantity, which minimizes the total inventory cost, is called the economic order quantity (EOQ). For the Eyssell Corporation, the EOQ is:

|6,240,000 2,498 units

Thus, for Eyssell, the economic order quantity is 2,498 units. At this level, verify that the restocking costs and carrying costs are both $936.75.

EXAMPLE 21.2 |

Carrying Costs

Thiewes Shoes begins each period with 100 pairs of hiking boots in stock. This stock is depleted each period and reordered. If the carrying cost per pair of boots per year is $3, what are the total carrying costs for the hiking boots?

Inventories always start at 100 items and end up at zero, so average inventory is 50 items. At an annual cost of $3 per item, total carrying costs are $150.

EXAMPLE 21 3 ■ Restocking Costs

-1—' In our previous example (Example 21.2), suppose Thiewes sells a total of 600 pairs of boots in a year. How many times per year does Thiewes restock? Suppose the restocking cost is $20 per order. What are total restocking costs?

Thiewes orders 100 items each time. Total sales are 600 items per year, so Thiewes restocks six times per year, or about every two months. The restocking costs would be 6 orders x $20 per order = $120.

EXAMPLE 21.4 |


Based on our previous two examples, what size orders should Thiewes place to minimize costs? How often will Thiewes restock? What are the total carrying and restocking costs? The total costs?

We have that the total number of pairs of boots ordered for the year (T) is 600. The restocking cost (F) is $20 per order, and the carrying cost (CC) is $3. We can calculate the EOQ for Thiewes as follows:

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